Question

The financial manager has determined the following schedules for the cost of funds:

Debt ratio		Cost of Debt		Cost of Equity
0	%	4	%	12	%
10		4		12
20		4		12
30		4		12
40		4		14
50		6		16
60		9		18

1. Determine the firm’s optimal capital structure. Round your answer to two decimal places.

   The optimal capital structure consists of 30% debt resulting in the cost of capital equal to 9.6%.

2. Construct a simple pro forma balance sheet that shows the firm’s optimal combination of debt and equity for its current level of assets. Round your answers to the nearest dollar.

   Balance Sheet
   Assets	$600		Debt	$	180
   			Equity		420
   				$	600

1. If the firm is operating with its optimal capital structure and a $500 asset yields 10.0 percent, what return will the stockholders earn on their investment in the asset? Round your answer to two decimal places.

     %_______?

Answer 1

The optimal capital structure demands 30% debt. Therefore, in this case from $500, 30% need to be deducted.which is $150. Rate of interest that need to be provided to the stakeholders on investment is 9.6% (give). Interest = $500 - $150 = $350 * 30/100 = $33.6.